Google Has Motorola, Now Comes the Hard Part

Google may have paid $12.5 billion for Motorola Mobility because of the patents, but now that the deal has closed, Google will have to face the toughest management challenge in its history.

The search giant surely understands the stakes; internally, Googlehas circulated its plans for Motorola among an unusually small group of top executives. Many other senior people don't know what businesses Google may have committed to spin out of Motorola in order to get the deal done, how many layoffs will be coming as part of the deal, and whether Google actually plans to hang onto competitive and low-margin businesses like set-top boxes and low-end phones.

It's not an exaggeration to say how Google digests Motorola is likely to define the company over the next two years. If Google moves swiftly to jettison products, real estate and workers who don't fit the company's larger mission, we may look back on this as the moment when Google locked in its momentum in mobile technology. If not, this may hobble the company and its stock.

The main issue with Motorola is cost. It is simply a sprawling bureaucracy. Last year it had 20,500 employees in 40 countries (including a manufacturing operation and 3,000 workers in Brazil alone.)

At the same time though, Motorola Mobility is at the mercy of a relatively narrow set of customers. In 2011, 19 percent of sales flowed through Verizon. And while 75 percent of Motorola's customers are in the Americas, its biggest growth market is China — a country where Google hasn't had the best relationships.

Perhaps no business issue demonstrates Google's challenge more clearly than low-end phones. Motorola shipped 18.7 million smartphones in 2011, and 22.7 million not-so-smart phones. The smartphones use Google's prized Android operating system. The rest — which, you'll notice, is most of them — do not.

The easiest course of action might appear to be dropping the low-end phone business altogether. (Apple , for example, doesn't sell anything but smartphones.) But that could be trickier than it sounds.

Eliminating half of Motorola's phone volume would mean paying higher prices for components. Getting out of the low-end phone business would also mean ceding huge portions of strategically important markets like China and Latin America to Samsung and a growing cohort of Chinese upstarts. Dropping low-end phones could also make it harder to convince some carriers to buy Motorola's smartphones.

So what's Google to do? From where I sit, the company has three broad options:

One: Drop the low-end phone business and set-top boxes. Google could then lay off or spin out half of Motorola's workforce, keeping the people who are focused on building smartphones and tablets.

Downside: Give up China and Latin America, at least in the near term. Upside: preserving profitability and focus.

Two: Keep low-end phones and set-top boxes, and try to become a hardware company. Lay off just a couple thousand employees. Develop expertise in managing a high-volume consumer supply chain, become a full-fledged competitor to Android's most important partner (Samsung), and figure out how to make nice with China in order to grow in that market.

Downside: expensive in the near term. Upside: dramatically expanded revenue potential, and margins could improve over time.

Three: Try to have it both ways. Keep some low-end phones, but try to cut selectively within Motorola's massive workforce. Try to run Motorola as a completely separate business from the rest of Google, ignoring the fact that Samsung and Apple will squeeze it at the high end, and Huawei and ZTE at the low end.

Downside: This would gradually erode Google's profitability until management eventually decided to do something about Motorola's decline.